Deutsche and Lyxor in major physical ETF U-turn

Deutsche Bank and Lyxor Asset Management are making their first foray into the physical exchange traded fund (ETF) space, marking a major turn for the stalwart swap-based providers.

Db X-trackers, the ETF arm of Deutsche Bank and second largest issuer in Europe, is launching a range that allows investors to choose between physical and synthetic replication of major equity benchmarks.

The initiative, which will see the first of the new funds launched in December, will allow investors to choose between physical and swap-based db X-trackers ETFs tracking German, US, Japanese, British and eurozone equity markets.

The new physical, or ‘direct replication’ products will include the identifier ‘DR’ in the fund names.

‘This is a significant step. For the first time investors will be able to go to a single provider and choose not only the type of market exposure they want, but also the type of tracking method they feel most comfortable with,’ says Thorsten Michalik, global head of db X-trackers.

‘Some client segments have shown a preference for direct replication, and as a provider we aim to meet that demand.’

In terms of fees, db X-trackers said the new physical fund tracking the EuroStoxx 50 will have a total expense ratio (TER) of 0.15%, versus its swap-based or ‘indirect replication’ fund, which has a 0% TER.

The provider said for other ETFs in the new range, fees will be the same for the direct and indirect versions.

Physical ETFs are also able to engage in securities lending and db X-trackers said the new direct replication funds will lend securities, which will help offset tracking difference.

Although the practice of securities lending can reduce over-all costs, it also introduces counterparty risk, in the event the borrower of the stock defaults. Db X-trackers said it intends to publish the underlying collateral on the website, on a daily basis.

Meanwhile, Lyxor – the pioneer of the swap-based ETF method – is converting four of its synthetic ETFs into physical funds, based on the EuroMTS Macro Weighted AAA Government Index series, in early December. The conversion will see the funds retain the same charges.

The move by both product providers comes as they transition their ETF operations away from their parent investment banking groups towards their asset management arms.

Earlier in the year Lyxor re-organised its ETF businesses and created a new ‘ETF and Indexing’ unit, headed by Lyxor chairman Alain Dubois.

The swap-based structure came under substantial regulatory scrutiny last year, amid concerns over collateral quality and counterparty risk.

Credit Suisse’s ETF arm – which is rumoured to be up for sale – also converted a range of its swap-based products to physical funds.

However, in the summer of this year, the European Securities and Markets Authority came out with its final guidelines on ETFs and other Ucits issues, clamping down on securities lending rather than swap-based ETFs.

In the guidelines, it focused on the issues of tracking error, collateral disclosure and the need for 100% of revenues, net of fees, from securities lending to be delivered back to the fund.

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